Operating leases and borrowing – does your supplier understand the impact of FRS102?

It is well known that all schools are unable to enter into an arrangement of borrowing money without the written consent of the Secretary of State (SoS), however it seems that the distinction of what is a finance lease and what is an operating lease can be difficult to understand. With the increasing funding pressures on schools, leasing is likely to become a more viable option than outright purchase. Therefore identifying the difference between an operating and finance lease will be crucial.

The introduction of FRS102 from 1 January 2015 also complicates matters as the lease classification rules have changed. Many suppliers inform schools that they are NASBM approved and therefore their leases comply with the rules of the Academies Financial Handbook as part of the negotiation process – however, this could be subject to change following the introduction of FRS102.

Under old UK GAAP there was the following key criteria that tended to suggest more towards a lease that constituted borrowing and therefore would need SoS approval. These included:

• Payments made to a finance company by the school which included the full value of the asset and also a financial return for the finance company
• Risk and rewards with the asset (including liability for theft, maintenance, repair etc)
• Whether at the beginning of the lease the minimum amounts required, are in excess of 90% of the assets’ true value

The “90% rule” is a key one. Many suppliers sell the lease as an operating one on the basis that the minimum amounts required are less than 90% of the assets’ true value. However, under FRS102 the “90% rule” is no longer in place. Therefore if all other criteria points to the lease being a finance lease (risks and rewards etc) and the minimum amounts are less than 90% – the lease is a finance lease and requires SoS approval.

More details regarding the new rules under FRS102 can be found in a bulletin on leases from the Financial Reporting Council.

Academy schools have more control over their budgets and have greater flexibility with purchasing options. It would be advisable to ensure any “purchased” or acquired assets have been done so, under the right agreement and challenged where not with the supplier/finance company.

Another question is what about leases that were entered into before the introduction of FRS102? These may have been deemed operating leases under the old rules but would now be a finance lease.

We asked the EFA what their stance would be from a regularity perspective and were provided with the following:

“If a school originally takes out an operating lease, it can’t become a regularity issue later on, as it was classified as an operating lease at the time.”

Therefore, only leases entered into since 1 January 2015 will be subject to the new rules.

Finally, we also asked if the EFA were confident academy schools were aware of the changes in the rules. The EFA replied with “We believe schools are aware of the points you have raised.”

Therefore we urge all schools to consult with their advisor prior to entering into any lease to ensure it complies with the Academies Financial Handbook and the new rules under FRS102.

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